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What is foreign direct investment?

At first glance foreign direct investment (“FDI”) sounds, well just that- “foreign” and hard to understand. So let me try to shed some of the obscurity. I am by providing a high level overview of what FDI is and a few things to consider.

Many times a businesses will find themselves with the need to expand across national boundaries to tap into new resources, reduce supply-chain costs, form strategic alliances, tax benefits and a host of other reasons, for the purpose of making an economic gain. One such way a business entity can find itself embracing the benefits – and yes, challenges too- of a foreign country is to make a direct investment. FDI is when an entity in one country, commonly known as the home country, invests into a host country by either purchasing an existing business in the host country or expanding its entity’s operation into the host country – perhaps by building a manufacturing facility or forming a partnership.  Such decisions, however, are accompanied by both opportunities and risks.

Let’s take a look at some of the benefits and challenges associated with FDI.

There are at least two broad benefits I can think of when discussing FDI. FDI first allows the business entity to establish a global presence.  With the rise of globalization, having an international presence can certainly be beneficial. In addition to those benefits mentioned above, FDIs can be used to take you, physically, to the very markets you are involved in or intend to capture. Let me give you a quick example. Let’s say company “X” the manufacture of widgets. The widget are sourced, procured, and manufactured in China, but the sale of the widgets is to a wholesaler who then redistributes to retailers in China. Company “X” may think to itself if it eliminates the middleman, it may be able to make an economic gain. Company “X” thinks if it established a physical presence in China by owning a shop or series of shops, the rest middleman would be history. Assuming the business case makes sense – and believe me it would be a long business case-, company “X” can accomplish such a goal by making a FDI. The investments would be directly made to open up physical locations so that company “X” can sell its product without the use of middle guy.

A second benefit provided by FDIs, are those that benefit developing countries who see the injection of foreign capital as a prime way of boosting economic growth. In addition to the direct benefit of job creation, the host country will find itself with accessing to new technologies, and new business management practices.

Of course, FDI has its challenges. With FDIs you have your typical business decision risks like foreign exchange rates, cultural and communication differences, political changes, tax consequences, human resource concerns, legal repercussions, and intellectual property protection – just to name a few. In some countries, like China particularly, you have to carefully navigate the government’s attitude and policy towards certain forms of FDI, and the complicated regulatory requirements.

So remember, one way a company can gain an economic benefit is to hop across town and set up shop in a foreign country by way of a foreign direct investment. But, one must tread carefully because the glamorous benefits are typically accompanied by inherent, and unforeseen pitfalls.

Mike Bellamy is an Advisory Board Member & Featured Blogger at the not-for-profit China Sourcing Information Center. He is also the author of "The Essential Reference Guide to China Sourcing" and founder of PassageMaker Sourcing Solutions.

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